and Probate Law Firm
A disregarded entity is a legal and tax classification applied to certain business entities, typically limited liability companies (LLCs) and single-member limited liability companies, for federal income tax purposes in the United States. As an estate planning lawyer in Portland, I have seen this come into play in terms of estate planning for clients who own rental property or other businesses or companies. The term “disregarded entity” means that, for tax purposes, the business entity is disregarded or treated as non-existent, and its activities and finances are reported directly on the owner’s personal tax return. Here are some key points about disregarded entities:
- Single-Member LLCs: A single-member LLC is an LLC with only one owner. By default, the IRS treats a single-member LLC as a disregarded entity for federal income tax purposes.
- Pass-Through Taxation: Like other pass-through entities, disregarded entities do not pay federal income taxes at the entity level. Instead, the business’s income, deductions, and tax liability flow through to the owner’s personal tax return. This helps to avoid “double taxation”, meaning taxation on the company’s profits and then again for any profits distributed to the owner.
- Reporting on Schedule C: Income and expenses of a disregarded entity are reported on Schedule C (Profit or Loss from Business) of the owner’s Form 1040 individual tax return. This is the same form used by sole proprietors.
- Limited Liability: Although the business entity is disregarded for federal income tax purposes, it retains its limited liability protection. This means that the owner’s personal assets are typically shielded from the business’s liabilities.
- Employment Taxes: A disregarded entity is generally responsible for employment taxes (such as Social Security and Medicare taxes) for employees. The owner reports and pays these taxes on the individual tax return.
- State Taxation: State tax treatment of disregarded entities can vary. Some states follow the federal classification, treating them as disregarded entities for state tax purposes. Others may have their own rules, so it’s essential to understand the tax regulations in the specific state where the business operates. It is recommended to consult with a tax professional for the most accurate advice.
- Conversion to Multi-Member LLC: If a single-member LLC adds additional members, it may no longer be treated as a disregarded entity for federal tax purposes. Instead, it would be treated as a multi-member LLC, which is typically taxed as a partnership.
- Election to Change Tax Classification: In some cases, a single-member LLC can elect to be taxed as a corporation rather than a disregarded entity. This election is made by filing IRS Form 8832 (Entity Classification Election).
- Other Entities: While single-member LLCs are the most common disregarded entities, other entities can also be treated as such, depending on the specific circumstances. For example, a grantor trust is often disregarded for federal income tax purposes.
Understanding the tax classification of your business entity is crucial for proper tax reporting and compliance. If you have questions about whether your entity should be treated as a disregarded entity or if you’re considering changing your entity’s tax classification, it’s wise to consult with a tax professional. Additionally, if these questions are part of an overall estate plan, you should also consult with a Portland estate planning attorney who can provide guidance based on your specific situation and goals. If you have any other questions about disregarded entities and estate planning, contact Thapar Law at 503-295-9741 or send us a message.
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